Home renovation loans gain favor in hard times

When Emre Bicer bought a Clifton, N.J., home, he decided to upgrade it before moving in. He had the roof replaced, a bathroom renovated and wood floors refinished.

“It looks like a brand-new house,” said Bicer, a 25-year-old information technology professional who bought the home with his brother.

The Bicers paid for all this work with a special type of loan backed by the Federal Housing Administration. The loan, called a 203(k), is used for renovations, and is different in several crucial ways from a home equity loan.

It’s not right for everyone, but it is useful for homeowners or buyers who don’t have much equity in the property, as well as for those who would like extra oversight on their contractors’ work.

Bill Trees, a vice president with Wells Fargo, calls 203(k)s “one of the industry’s best-kept secrets.” Some lenders are pitching these loans to homeowners whose houses were badly damaged by Superstorm Sandy.

The 203(k)s, which are not available to investors, generally come with higher fees and interest rates than home equity loans, because they carry FHA insurance. The interest rate is typically about three-eighths of a percentage point higher than a similar home equity loan, according to Steve Marshall, national director of renovation loans at River Edge, N.J.-based Real Estate Mortgage Network. And the homeowner must pay a fee to a consultant who oversees the construction work and may also face an extra lender’s origination fee of up to $350.

The loans also require more paperwork, lenders say.

These loans have grown in popularity during the housing bust, which has poured millions of distressed homes onto the market across the nation. In 2012, more than 21,000 of these loans were written nationwide, according to the federal Department of Housing and Urban Development. That’s up from only 3,635 in 2007, before the housing market’s collapse.

The 203(k) loans can be used either when a home is bought, as in Bicer’s case, or later, after the owner already lives there. There are two types — a regular 203(k), for extensive repairs, and a streamlined version, for more modest upgrades worth up to $35,000.

When borrowers apply for a 203(k), the lender qualifies them based on their credit scores, as with other loans.

With a regular 203(k) loan, borrowers must provide a detailed estimate from the contractor.

The homeowners then must hire a consultant trained by HUD, who will go to the property and see if the work plan is feasible and if there are any health or safety issues that must be corrected. The borrower pays the HUD consultant $250 to $1,200, depending on the complexity of the project. (The streamlined 203(k) does not require the consultant.)

If the loan is approved, the interest rate is negotiable between the borrower and the lender. When the loan is made, the money goes into escrow and is paid to the contractors in stages, only after the HUD consultant checks the work. (Under the streamlined option, the lender can choose to pay the contractor up to 50 percent of the project cost upfront.)